Don’t Cash In Your Retirement Savings When Changing Jobs

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When changing jobs many employees tend to cash in their retirement savings before embarking on their new career paths. This decision can however be a short-sighted one as it could negatively affect your retirement planning in the long run.

The main reasons for this negative effect being:

  • Loss of compound interest
  • Retirement fund tax incentives
  • Taxation of retirement benefits 

Loss of compound interest

Compound interest is often defined as earning “interest on interest” and plays a major role when it comes to investing as it allows you to not only earn interest on the principal amount invested, but also on the interest earned.

By accessing retirement funds prematurely this compounding effect is cut short and then needs to be made up for in contributions or additional growth at a later point in time.

This places additional pressure on your budget and/or your investment performance.

This means that in order to achieve the same goals, you will have to save more money or achieve higher returns on your investments.

Retirement fund tax incentives

Retirement funds such as Retirement Annuities, Pension Funds, Provident Funds, Pension Preservation Funds and Provident Preservation Funds are not subject to income tax, capital gains tax or dividends tax.

Therefore by utilising these investment vehicles you improve your chances of earning higher returns over the long term based on the tax incentives provided.

Taxation of retirement benefits 

Retirement fund lump sums are taxed differently dependent on when you access the funds (pre- or post-retirement).

When accessing retirement lump sums before retirement, members are taxed according to the withdrawal tables, as opposed to being taxed according to the retirement tables when accessing the funds after retirement.

This is best illustrated in the following example:

Mrs. Smith (age 35) has resigned from her current employer and has built up retirement savings of R300 000 in her employer’s provident fund.

If she transfers this capital to a Provident Preservation Fund and does not make any early withdrawals from any other retirement funds, she may on retirement withdraw the first R500 000 tax-free. This is in accordance with the retirement tax table (see below).

Taxable Income (R) Rate of Tax (R)
0 – 500 000 0% of taxable income
500 001 – 700 000 18% of taxable income above 500 000
700 001 – 1 050 000 36 000 + 27% of taxable income above 700 000
1 050 001 and above 130 500 + 36% of taxable income above 1 050 000

 

If however, she decides to withdraw the full fund value in cash at resignation, only the first R25 000 will be tax-free, while the balance of R275 000 will be taxed at 18%, which amounts to R49 500.

This is in accordance with the withdrawal tax table (see below).

Taxable Income (R) Rate of Tax (R)
0 – 25 000 0% of taxable income
25 001 – 660 000 18% of taxable income above 25 000
660 001 – 990 000 114 300 + 27% of taxable income above 660 000
990 001 and above 203 400 + 36% of taxable income above 990 000

 

Ultimately there will always be various arguments to support both preservation and withdrawal.

But one of the biggest benefits offered by preserving your retirement savings is the fact that it restricts you from accessing the funds prematurely and therefore enables you to keep the funds for its original purpose – retirement.

Pre-retirement withdrawals from retirement funds should therefore be seen as a funding of last resort and avoided if possible.

[tip title=”moneysmart tip”]Try to build up an emergency fund of between 3 – 5 months’ salary so as to avoid withdrawing from retirement funds or incurring debt when changing jobs.[/tip]
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About Author

Raul Jorge is a CFP® professional at PSG. He specialises in estate, investment, retirement and risk planning. Prior to joining PSG, Raul completed his BSc (Honours) in Business Administration through the University of Wales and more recently completed his Postgraduate Diploma in Financial Planning through the University of Stellenbosch.